 Hello, and welcome to this session. This is Professor Farhad. In this session, we would look at short term debt expected to be refinance. This topic is covered in intermediate accounting. The CPA exam, the FAR section. As always, I would like to remind you to connect with me on LinkedIn if you haven't done so. YouTube is where you would need to subscribe. I have 1,600 plus accounting, auditing, tax, and finance lectures. This is a list of all the courses that I cover. If you like my lectures, please like them. Click on the like button. It doesn't cost you anything. Share them, put them in playlist. Especially these days, if they benefit you, it means they might benefit other people, so share the wealth. And please connect with me on Instagram. On my website, you will find additional resources such as PowerPoint slides through false multiple choice. If you're studying for your CPA exam, thousands of multiple choice questions. So if you are serious about passing the exam, I strongly suggest you check out my website. So what is the big idea of short-term debt expected to be refinanced? Remember, short-term debt is short-term obligation, a short-term debt, debt. Remember, short-term debt is a current liability. So let's, what does it mean something to be a current liability? Well, if we're looking at year one, and this is where preparing the balance sheet as of year one, and we look forward to year two. So this is year two. So the balance sheet is let's assume December 31st. And anything that's, any liability, any debt that's gonna be paid off within the next 12 month or the company's operating cycle, we're gonna assume the company's operating cycle is 12 month, any debt that's gonna be paid within the next 12 month will be considered short-term obligation. Now the question is, what happened if you are expecting to refinance this debt? What happened if you are expecting to refinance this debt? Well, the reason why we care about this is because the definition of a current liability is part of it is the use of current asset. When you have a current liability, it's gonna be do within the next 12 month or the company's operating cycle or the use of, and or the use of current assets. So what happened if you are planning to refinance? Simply put, you don't have to worry about your current assets. What do we have to do with this? Well, the old rules, I'm gonna first briefly talk about the old rules because it makes sense to look in the light of the new rules. The old rules is this, if you had the ability and the intent, so on December 31st, let's assume the financial statements will be issued March 1st. The old rules were if you had the ability and the intent, the ability and the intent to refinance before March 1st, if you can show the ability and the intent to refinance before March 1st, then you can reclassify this loan as long-term. Well, the ability and the intent in a sense, they are considered subjective. Basically, management decides whether they have the ability and whether they have the intent. I mean, they have to show that they have the ability. For example, they're negotiating with the bank about a line of credit or a new loan. But the new rules basically changes this subjectivity and says now you can only execute the new rules. You can execute this liability from current liability if one or both of the following conditions exist. So now you need to have a little bit more stringent rules. So let's take a look at what are those rules, okay? One of those, one or both? No, both, if it better. One, the liability is contractually due to be settled more than one year after the balance sheet. Well, that's obvious. Now if you have a contract that the liability is due longer than one year, then guess what? It's no longer a current liability, which is good. But notice it has to be contractually due. So in the contract somehow, it has to be written and or the entity has a contractual right. Remember, now you are dealing from a contract. It's not you have the intended and the ability. Do you have a contract to defer the liability for at least one year after the balance sheet date? Remember, you count one year from the balance sheet date. We assume your operating cycle is one year. Do you have a contractual right? And this has to be by the balance sheet. You have to have this information by the balance sheet date. What is the balance sheet date? The balance sheet date we're gonna assume here is December 31st. Do you have one or both? I mean, if you have both, it's better, but do you have one or both of these conditions? And the best way to illustrate this is to look at an example. So notice here they are taking the contract approach versus intent and ability. Well, contract is better because it's more objective. Can you show me you had that contract? Can you show me that you refinanced? So on November 30th, 2020, ABC company issued a note payable of 3 million. So basically, let's take a look at a timeline. Maybe this will illustrate the concept. So this is November 30th. This is November 30th, 2020, or year one. The note is due February 28th, 2021. So I'm gonna change the color for year two, just kind of, so let's assume this is December 31st. This is the year end. It's due this, they have to pay it back February 28th. They have to pay the Sloan February the 28th, 2021, 2021. And their balance sheet date is December 31st. So this is the year end, December 31st is year end. You have to pay it back on February 28th. And the financial statements are issued March 1st. The financial statements are issued 3, 1. The financial statements are issued March 1st. At that time, it planned to extend the maturity date of the loan to June 30th, 2022. So what they're planning to do now, as they're planning to refinance, extend the maturity, extend the maturity in a form of refinancing, the loan to June 30th, 2022. So June 30th, 2022, the loan becomes long-term because June 30th, 2022 is basically you are talking more than a year from the balance sheet date. So this is what we have here. So let's take a look at the scenarios. What is the accounting treatment for ABC short-term that to be refinanced if the contract to refinance is completed by January 15th, 2021? Here is the contract is signed January 15th. So when is it signed? It's signed after year-end, it's signed after year-end, January 15th, after the year-end, but before the financial statements are issued. Under the old rules, under the old rules, well, here we can show intent, we can show ability. If we can show the contract to refinance is completed. Under the new rule, that's not the case. We would still show the three million as a current liability because it's not completed by December 31st, not December 31st. Refinancing after the balance sheet date does not affect the liquidity or the solvency at the balance sheet. So it's not affecting your position because as of December 31st, you don't have the contract signed. That's it, period. Now, what if the accounting treatment for the short-term that to be refinanced if the contract to refinance is completed by December 31st? Here we completed the contract before year-end. Before year-end is obviously some place here by December 31st, before year-end. If that's the case, now the refinancing did occur before the balance sheet date. Therefore, it will be non-current because the contract is completed. The rights defer till payment till June 2022. So now what we do is we take this current liability, the three million, and reclassify it as long-term because we did complete the contract before December 31st. Now you could definitely imagine why FASB changed the rules because companies were abusing those rules. They would just say, they would say we have the intent and the ability to refinance the loan and they would reclassify it as long-term rather than short-term. And as a result, it will increase their current ratio. It will increase their liquidity position. It will increase their solvency position because they are deferring, especially their liquidity position. They're deferring short-term debt. They are showing that they don't have that cash flow pressure in the near future. Well, in reality, they really could not, for example, refinance. So that's the fear. That's why FASB made the rules kind of stricter, more strict because intent and ability is really subjective. So that's the whole idea behind the change of the rule. Now, as always, I would like to remind you, if you like this lecture, please like it, share it, put it in playlist. 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